Killing innovation for the public good?

It is a truism that investors like certainty. They also like a return on investment. This cannot even be described as economics - it's just common sense. If, as a Government you intervene in a market, then you had better ensure you don't create uncertainty and that you enable market players to secure a return on investment. This is precisely where Labour's newly announced policy to cap energy prices fails: certainty and opportunity.

Essentially, price caps suspend the market. The price mechanism is a vital signalling device. When it is disabled then the market doesn't really function anymore. The information about incentives to invest is silenced. When a Government caps price, in itself this is a signal. The Government is willing to essentially suspend this market. Investors and entrepreneurs read this as 'avoid at all costs.'

So we are still left with a concentrated, poorly regulated energy market in sore need of investment to meet our energy, living costs and environmental needs. There is a trade-off between these three objectives. Vertical separation between retail, wholesale and generation prices might be necessary. Providing capital and wholesale price support for new entrants who help us meet our energy and environmental needs might also be a worthwhile intervention. Even a break-up of the big market players on horizontal as well as vertical lines could work. Price regulation could well be a component element of a functioning market in the short-term at least. These are all possible and necessary components of a new institutional structure for the market. However, the last thing you want to do is cap prices- especially if you want to encourage new entrants, new innovation, new ideas, new competition.

What happens when you start controlling prices in a market that has a degree of volatility? I'm afraid it's difficult to get away from the Californian power catastrophe in the early 2000s- bankruptcy and under-investment.

Come 2017 when the price cap came to be reviewed, a Miliband Government would be faced with a choice: lift the cap and prices explode or keep it in place and increase the chance of market failure. That's if the market failure hasn't already happened. Keep it in place and you are basically nationalising the energy market. Remove it and prices may pop, encouraging another intervention. The Government gets politically locked in. Both routes are likely to eventually pass financial responsibility to taxpayers. Do we really want to choose between investment in power stations and investment in healthcare? Hayek would recognise this unintended mission creep from politics to state expansion very well - assuming it is unintended.

Elsewhere, in Ed Miliband's conference speech he articulated, in a very clear fashion, the importance of promoting small business and safeguarding the environment. The price cap denies opportunities for new players to enter the energy market - including the type of municipal suppliers common in Europe and the US. New investment could accelerate progress towards environmental objectives; without it progress will stall.

There is a bigger point here. This energy example marks a shift in Labour's approach. The 'use it or lose' it policy on land has similar deficiencies which would end up in the expansion of central state power too. Labour orthodoxy over the last twenty years has involved an accommodation with the market as one element of driving growth and providing opportunity. Justice and efficiency are bound inseparably together in this model. The market can be reformed, regulated, and loaded but it had a place in Labour's worldview.

Miliband's speech yesterday - in a seemingly harmless fashion - broke with that orthodoxy. The policy on energy price caps is clear and it will be popular. Its consequences wouldn't be and significant damage can be done. Once you give up on the market mechanism - albeit one that is regulated or has a mixed economy form - then that will create its own dynamic. If you are going to have price controls or property confiscation in energy and housing, why not food, petrol, pharmaceuticals, internet and mobile telephony, sanitary products, baby's clothes, foreign travel, books, or funeral services?

These are all choices ultimately. They are all things which impact on the cost of living. They all have varying degrees of regulation and market structure currently. But it's a bad idea to remove the price mechanism from the markets that govern them- regardless of how heavily regulated they are.

You can write a very long list of reasons why price controls are a bad idea. Essentially, they kill innovation in the name of a public good and cause harm as a consequence. There is one good reason for them from a political party's perspective - short-term politics.

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